Prospect theory assumptions

CFA Level III Portfolio Management
#1

Guys,

Schweser says that Prospect theory “further relaxes the assumption of risk aversion and instead proposes loss aversion”. Before that, they say "Bounded Rationality relaxes the assumptions of perfect information and maximizing expected utility.

Does that mean the Prospect Theory also assumes the removal of perfect information, fully rational decisions, utility maximization and knowledge limits - just like in the Bounded Rationality?

Or does it simply assume loss aversion instead of risk aversion? Thats What the table on P.74 suggests from What i understand.

#2

Anyone?

#3

Why you over thinking about both theories ? Both are separate theories and has nothing to do with each other.

#4

I am just wondering what they mean by “further relaxes” as per my quote above.

#5

They mean that prospect theory doesn’t assume risk aversion; it assumes loss aversion.

When they say that prospect theory “relaxes” the assumption of risk aversion, what they mean is that it abandons that assumption. “Relaxes” sounds more genteel than “abandons”.